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It's been another up-and-down week for forex markets. We started the week in risk-seeking mode, but that waned as we progressed through the week and by the start of yesterday's European session risk nose-dived as investors were spooked by renewed concerns about the political uncertainty in Egypt and worries that inflation concerns will slow global growth. The dollar has been the chief beneficiary - the greenback has risen by 1.5 per cent over the last two days on a broad-based basis. EURUSD has lost its momentum and fallen below 1.3595 - the top of the Ichimoku cloud. The pair is now bouncing along the 1.3520 zone, and a weekly close down here would spell further losses for the single currency.

The yen and Swiss franc have been hit the hardest by the dollar's resurgence, as the greenback takes the prize for most sought-after safe haven. A weekly close above 78.55 - the base of the daily Ichimoku cloud chart - in the dollar index would be positive for an extension of dollar gains next week, and we could see back to the 80.00 highs from last month.

A stronger dollar is weighing on commodities and stocks. The Eurostoxx index is down more than 1 per cent so far today, and the futures market is pointing to a weak opening for US stocks. While the euro is being weighed down by the rise in the dollar, European equities are getting hit by concerns about the solvency of Portugal. Its 10-year lending costs are back at unsustainable levels, above 7 per cent, which is the threshold that could cause the Iberian nation to apply for bailout funds from the EFSF rescue facility. This concern is weighing on sentiment towards the European banking sector, which holds a lot of the peripheral nations' debt. The financials' sector in the Eurostoxx 50 is down more than 1 per cent so far today, which is dragging down the entire market as it makes up nearly 30 per cent of the index.

The pound is performing fairly well, however GBPUSD is showing weakness and is currently below 1.6000. As expected, the Bank of England kept rates on hold yesterday but the sceptre of rate hikes has not evaporated. The market is still expecting 3 rate hikes this year, and the 3-month GBP swap rate has started to rise again after a sharp drop yesterday. The pound is still in an uptrend and we expect it to retain its bullish tone as we close the week. Next week, however, is a different ball game. The Inflation Report next Thursday is a major event risk for the pound as the Bank of England will give their outlook on growth and inflation for the next 2 years. This will highlight whether the market has been right to price in such aggressive hikes, or if it has got ahead of itself. Whatever the outcome, it has the potential to be a volatile time for GBP.

Elsewhere, the Aussie dollar is back below parity, falling in line with other risky assets. It was also weighed down by comments from RBA Governor Stevens who said that expectations of further rate hikes not taking place until the latter part of this year were okay, as the Bank was ahead of the curve on the inflation front due to its previous rate hikes since 2009. German CPI fell in January as expected, but the annualised rate remains at 2 per cent, which is at the high end of the ECB's target inflation rate. UK Producer prices for January reinforced the growing pressures in the inflation pipeline. This is likely to fuel further concerns about the Bank of England's inflation-fighting credibility and calls for the Bank of England to hike rates.

In contrast to this, the Federal Reserve is about to lose one of its hawkish members. Fed Governor Warsh is will step down on March 31. He was one of the more outspoken critics of the second round of quantitative easing.

Ahead today, the University of Michigan confidence data is out. It is expected to rise to 75.0 from 74.2 in January. The trade balance is also expected to deteriorate, with the deficit rising from $38.3bn to $40.5bn in December. This might garner some attention, as weak exports could weigh on growth going forward.

Data Watch:
13.30 GMT (0830 ET) US Trade balance Last -38.3 Exp 40.5bn
14.55 GMT (0830 ET) US Michigan Consumer Sentiment Last 74.2 Exp 75
17.30 GMT (1230 ET) EU Trichet speaking

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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